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EUR/USD: Federal Open Market Committee Interest Rate Decision

By , Currency Analyst
26 January 2010 18:48 GMT

Trading the News: FOMC Interest Rate Decision

What’s Expected

Time of release:        01/27/2010 19:15 GMT, 14:15 EST
Primary Pair Impact :    EURUSD
Expected:         0.25%
Previous:         0.25%

Effect the FOMC rate decision has had over EURUSD for the past 2 meetings

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December 2009 FOMC Interest Rate Decision

The FOMC held the benchmark interest rate at 0.25% and maintained its pledge to keep borrowing costs “exceptionally low” for an “extended period” as households continue to face a weakening labor market paired with tightening credit conditions. At the same time, the Fed held an improved outlook for the economy and said that the “deterioration in the labor market is abating,” while household consumption “appears to be expanding at a moderate rate.” As the central bank expects price pressures to remain “subdued for some time,” market participants anticipate the central bank to maintain its current policy throughout the first-half of the following year as the Fed aims to balance the risks for growth and inflation. 01.26_TTN2

November 2009 FOMC interest Rate Decision

The Federal Reserve borrowing costs at the record-low of 0.25% and said that the interest rate will stay at its current level for “an extended period” as the central bank aims to encourage a sustainable recovery in the world’s largest economy. The FOMC said that private spending has improved following the extraordinary measures taken on by the government, but “remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit.” At the same time, policy makers noted that firms continued to cut back on “fixed investments and staffing, though at a slower pace,” and the Fed is likely to maintain the expansion in monetary policy going into the following year as they continue to see a risk for a protracted recovery. 01.26_TTN3

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:

If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.
Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.
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How To Trade This Event Risk

The U.S. dollar is likely to face increased volatility over the next 24 hours of trading as the Federal Open Market Committee is scheduled to announce its rate decision at 19:00 GMT on Wednesday, and the central bank is widely expected to maintain its current policy as it aims to balance the risks for growth and inflation. A Bloomberg News survey shows all of the 93 economists polled forecast the FOMC to hold the benchmark interest rate at 0.25% this month, while Fed Funds Implied Probability shows investors are pricing a 54% chance for the central bank to keep borrowing costs at the record-low as policy makers continue to see a risk for a protracted recovery. The final 3Q GDP reading showed economic activity expanded less than expected, with the growth rate increasing 2.2% amid an initial forecasts for a 2.8% rise. Meanwhile, retail spending unexpectedly contracted 0.3% in December, and households may continue to keep a lid on consumption as they face fading demands for employment paired with tightening credit conditions. At the same time, non-farm payrolls slumped 85K in December despite projections for a flat reading, and the downturn in the labor market may continue to weigh on the outlook for future growth as private-sector consumption accounts for more than two-thirds of the economy. Nevertheless, the Fed’s Beige Book said economic activity improved in 10 of the 12 districts, with home sales increasing in most region, but went onto say that the labor market “remained soft,” which continued to put downward pressures on wage growth. In addition, the central bank noted that households remained “cautious, price sensitive, and focused on necessities, but sometimes willing to spend on discretionary purchases,” and stated demands for borrowing “continued to decline or remained weak” in most districts. As policy makers expect the labor market to remain weak throughout the first-half of the year and project price growth to remain subdued over the near-term, the central bank could maintain a dovish outlook for future policy as Fed Chairman Bernanke expects the economy to face “formidable headwinds” this year.

Trading the given event risk may not be as clear cut as some of our previous trades as market participants anticipate the FOMC to maintain its current policy but nevertheless, price action following the policy meeting could set the stage for a long dollar trade as the economy emerges from the worst recession since the Great Depression. Therefore, if the Fed raises its outlook for the economy and sees scope to normalize policy later this year, we will need to see a red, five-minute candle following the meeting to establish a sell entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will dictate our first target. Our second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in an effort to preserve our profits.

In contrast, the ongoing deterioration in the labor market paired with tightening credit conditions may lead the Fed to hold a cautious tone during its statement, and dovish language following the rate decision could drag on the greenback as investors weigh the outlook for future policy. As a result, if the FOMC maintains its pledge to hold borrowing costs at the record-low for an “extended period” of time, we will favor a bearish outlook for the reserve currency, and will follow the same setup for a long euro-dollar trade as the short position laid out above, just in reverse.

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Questions? Comments? Join us in the DailyFX Forum

To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com

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26 January 2010 18:48 GMT